e.Digital Corporation (fka EDIG)

[Tinroad]

Macrovision CEO Interview
(courtesy of murrayhill)
http://www.thetelecommanalyst.com/individual/010717sections/zeroin.asp

William Krepick, President and Chief Operating Officer
Interviewed by George S. Mack

At some point in your life, you may have copied some software, some music or a movie. If you've got a computer-savvy teenager in the house, then making copies of music under your roof is not a rarity. But it may not be quite as easy to do in the near future. Macrovision (MVSN) is in the business of protecting other companies' intellectual property. The Silicon Valley-based company uses its patented and copyrighted intellectual property to prevent people and illegal mass producers from making good copies from CDs, videocassettes, DVDs and even digital pay-per-view events from cable and satellite broadcasts. On June 29, Macrovision announced that four CD manufacturers are now using its new SAFEAUDIO technology. Although no major music labels have committed to the technology, the company says two major unnamed music studios are now beta-testing it. Macrovision is expected to grow revenue more than 35% this year and that much again in 2002. Between April 2 and July 6, investors who crave old-time technology growth and high margins voted with their dollars and bid up the Macrovision share price 50%. Now the stock is trading at a lofty 30 times this year's forecast revenue and close to 80 times this year's expected earnings. On July 5, I discussed the company's technology, capability and potential with President and Chief Operating Officer William A. Krepick.

[THE TELECOMM ANALYST — GEORGE S. MACK] You're obviously a software company, but of course, you're a technology company, and you could even be described as a media company. Does it all fit?

[WILLIAM A. KREPICK] Yes, but actually it's very hard to categorize us sometimes, because we haven't found any companies comparable to us in terms of our focus on protecting intellectual property. Sometimes we're categorized as a digital rights management [DRM] company, and I think there are a few companies in that space, but they don't cover the breadth of media that we do.

[GSM] Broadly speaking, you're a software company, but more narrowly speaking, DRM might be a better term.

[WAK] Right.

[GSM] I'm noting that Macrovision has been in this business for quite some time, and you have the patented standard for videocassette copy protection. How long has that been in use?

[WAK] The company actually has been in existence for quite some time, dating back to the early 1980s, and that was when we got into the business of videocassette copy protection. Subsequent to that, we came out with additional patents that could protect DVDs against being copied, as well as digital pay per view. We went public in the spring of 1997, so we've only been a public company for about four years now.

[GSM] Bill, if I bought a videocassette today, would I, in all likelihood, be able to dub it over to another tape?

[WAK] The odds are that if it was a Hollywood title — a major release — you wouldn't be prevented from copying, but it would force the recording VCR to make a horrible-quality copy. In today's market, literally every VCR being manufactured, sold or imported into the United States will react to our copy-protection signal, and you will get a bad copy. It's actually a requirement of U.S. copyright law that VCR manufacturers design and make their devices in a certain way so that they are affected by our copy-protection process.

[GSM] I have DirecTV [a unit of Hughes Electronics (GMH)], and the other evening I taped a pay-per-view movie so my wife could watch it later, and so I wouldn't have to pay for it again. It taped just fine. But I understand that you have the capability to copy-protect these signals.

[WAK] The capability is actually in the DirecTV box, but currently neither DirecTV nor any other satellite or cable operators in the U.S. are actually activating the circuit that's in the box. So today, you and anybody else can freely copy any pay-per-view program with no problem. What DirecTV and the other operators have suggested to the studios is that they are willing to turn on copy protection if the studios give them the movie releases on pay per view at about the same time they give them to Blockbuster (BBI), Hollywood Entertainment (HLYW) and other video stores. Today, pay-per-view movies on cable or satellite generally come out 60 to 90 days after they are released to the video stores.

[GSM] The cable and satellite operators are using copy protection as leverage to try and get the movies earlier?

[WAK] Yes.

[GSM] On June 29, you made an announcement that four CD manufacturer companies, with which you've had a long relationship — Toolex International (TLXAF), Eclipse Data Technologies, DCA and DaTarius Technologies — have recently adopted your SAFEAUDIO copy-protection technology. But they have all been using your SafeDisc software. Is SAFEAUDIO a better solution? Does it play across more CD players? What's the difference?

[WAK] SafeDisc is really aimed at the computer software market as opposed to the music CD market, and it's particularly aimed at the PC games segment of the software market. We have almost every major PC games company employing the SafeDisc technology today, and it does prevent one from burning a copy of a PC game and giving it or selling it to a friend. That technology has been in existence for two-and-a-half years, and we have in excess of 100 CD manufacturing plants around the world equipped with that technology. But SAFEAUDIO is designed specifically for music CDs.

[GSM] Making copies of Windows 98 or MS Office represents a huge loss for Microsoft (MSFT). Why aren't Microsoft and other software publishers routinely using this kind of technology?

[WAK] Well, we're actually talking to them about it. Microsoft already uses it on all of its PC games, and it uses it on its Encarta product. But for Microsoft's new operating system, Microsoft XP, which is slated to come out in late October, it's employing what's called enforced registration. This makes you go back to Microsoft's Web site to register the product. It hasn't adopted our solution, but obviously we're trying to sell the company on the benefits of ours. We think we've got a lot of features in ours that would make it user-friendly and would not interfere with the use of the program. Those types of companies are targets for us. We'd certainly like to sell Microsoft our SafeDisc, but we also have another product called SAFECAST, which allows you to electronically download software over the Internet, and you can further lock it to a particular PC. So we also have other products we're talking to Microsoft about.

[GSM] Why isn't there broader acceptance of this technology?

[WAK] Let's just look at the individual segments where we're involved. Look at the music segment. So far, the labels have been very, very conservative in getting involved with new technology. One of their concerns is that there will be a rather violent consumer reaction if they start copy-protecting music CDs. People feel they're entitled to make any number of copies of CDs or tracks. One of the things the music labels are concerned about is what will be the reaction if they just go ahead with copy protection. That's the first thing. Number two, they're justifiably concerned about how the technology works and whether or not someone with the original copy-protected CD might hear anything at all that might suggest any interference or artifact that might be caused by the copy protection. They are doing a tremendous amount of testing on that.

[GSM] The music labels could be blamed for artifacts or interference, whether it was true or not?

[WAK] Right. And in fact, you can go back in history to when we introduced the original videocassette copy protection, and there were many complaints that came into the studios about problems with the cassettes. The vast majority of time when it was tracked down, it was found there really wasn't a problem with the cassette, but people were actually complaining because they couldn't make a copy like they were accustomed to doing.

[GSM] You now have two major unidentified record labels beta-testing your SAFEAUDIO technology. When will we hear the results of that?

[WAK] I would hope that by the end of this year these companies would have been able to do enough testing, and that they would have put together their own internal strategy of how to deal with the issues we were just talking about. But we are operating under a non-disclosure agreement, and the labels may actually not want to announce results or the fact that they're even using SAFEAUDIO. They may just want to put it out into the market like a blind test so that nobody knows it's being used. People are less likely to complain if the only problem is that they can't make copies. So that would give the labels a better way to gauge the quality of the copy protection.

[GSM] Bill, since you can prevent piracy, will you be reimbursed on a royalty basis per number of copies sold?

[WAK] We hope so. Our business model for all our other copy-protection products allows us to get royalties per disk in the case of CD-ROM, per videocassette or per DVD. Even in the case of pay per view, we get a per-transaction royalty. In our initial discussions with the labels, we've told them that we would wind up pricing it that way. Obviously, we don't know yet what we can get. I think you could certainly make an argument that any label could see an attractive return on investment, probably at the $0.15 to $0.20 to $0.25 per-unit level. But based on our history of dealing with various rights owners — the studios on the video side and even our initial discussions with music labels — we're probably not going to be able to get that kind of a royalty. It's probably going to be $0.05 to $0.10 per CD or per album, and that depends on length of contract and minimum commitment. You can clearly make a case that the technology is that valuable. Now there are only five major music labels, and they wield a lot of power in terms of being able to negotiate tough contracts.

[GSM] Bill, how big is the piracy market?

[WAK] In music, I just saw a study done by IFPI [International Federation of the Phonographic Industry], and that organization put a number on it of about $4.2 billion. That's a combination of all types of piracy, including the illegal CD plants in mainland China, which pump out millions of disks. But I think IFPI's number for recordable CDs alone was 165 million units, which was up over two-and-a-half times since 1999. So if you figure an average of $10.00 per CD as the wholesale price that goes to the labels, then you're talking about a $1.6 billion loss. It's huge.

[GSM] Is anyone challenging your patents at this time?

[WAK] No. In every case going back to the late 1980s, we have basically brought forth the patent infringement suits and have challenged others. We have never been sued for patent infringement. We've got close to 400 patents, including international patents. In the U.S. alone, we have 50 patents issued, and we have another 45 or 50 patents pending.

[GSM] Because your business model is somewhat rare, it's hard for investors to judge the risk. In your opinion, what are the risks that Macrovision investors might face?

[WAK] Well, I think the risk is tied to our current valuation. I think we have a reasonable valuation, based on our history of growth. So I think the major risk is whether we can sustain that kind of growth across the board in our current businesses, as well as getting into new tangents and new enhancements of our current business. We've announced publicly that we're looking at 40% to 45% per year growth targets on both the top line as well as bottom line. We just need to continue to execute in each of these business areas that we're in to make it happen. So I think the investor risk is one of execution.